More ZIRP & QE Problems (Wednesday, October 06, 2010)

Repeating from a previous post, ZIRP stands for Zero Interest Rate Policy. While it dramatically improves a financial institution’s cost of borrowing, it has done very little for most businesses and citizens also known as consumers. In fact, whether one has a good credit score or not, interest rates and fees have generally jumped higher more than offsets to estimated risks.

ZIRP policies coupled with financial institutionalized Quantitative Easing (QE) have distorted price and rate discovery processes. Markets and asset classes tend to bind by the spreads or relational rates and prices. The various liquidity and other programs are seriously altering the financial landscape. By “forcing” down rates the balance or interaction between potential borrowers and lenders has been misaligned. For example, one often hears or reads about dramatically lower mortgage rates. While on the surface that might look great for a potential borrower it is not so great for potential lenders. Given the traumas in the mortgage and real estate market it is little wonder that bona fide investors are leery.
Forceful market interventions are akin to squeezing a water balloon. The more you squeeze the more distorted the balloon (financial economy) becomes. Once the balloon starts to leak, further squeezing or efforts to refill with more liquidity to restore a prior condition and repair the balloon or bubble will be negated by the rupture.
To use another analogy consider the economy as an automobile. In the beginning its usefulness was high and fuel efficiency acceptable. However, with the passage of time it took increasing amounts of fuel to go a set distance. In other words it became less efficient and subject to other negatives. Then one day, the operator of the vehicle wanted to do the daily drive but was unable. The tank was empty. The operator kept pouring fuel into a ruptured tank. Initially, the vehicle moved but the continuation of further liquidity injections made for a far more volatile situation. Since increasing numbers of Central Banks (CBs) are pursuing ZIRP and QE policies it is a just a matter of time to see the impacts on currencies and other things.
ZIRP is damaging the savings structure and culture because it is an artificial procedure that biases the savings, investment, consumption, production matrix among other things. It seems that many but not all Ph.D. economists never learned or acknowledged how to make change for a dollar or other currency for that matter. Moreover, “constructs” such as all other things being equal serve a role in discussions, this ceteris paribus group fail to account for countervailing or other dominant forces.
Basic knowledge indicates that if you produce $1.00 of total production and that total production is consumed then 100 cents of production occurred and 100 cents of consumption occurred with the end result of zero (0) savings. If you produced $1.00 and consumed 95 cents then you saved 5 cents which could be used for investment, lent out or saved/stored for future production. That is the proverbial seed corn. If you produced $1.00 and consumed $1.05 that deficit has to come from some where. That somewhere would be from and existing stock of wealth or borrowing thus being indebted.
Pursuing ZIRP as a tool to encourage consumption versus savings/investment is dangerous. This is especially so since years of accumulating debts – indebtedness - due to overconsumption have sapped the ability of many if not most to service disproportional debts. Trying to reset an economy that was over-consuming to an over-consumptive state once again is destined to ultimate failure. Intuitively, you can see that if one only produced $1.00 every year but consumed progressively each year that the cumulative deficit will keep growing. If you should compound the interest then you have the makings of an exponential drain versus an arithmetic/stationary production base. In today’s world the printing of money does not generate the necessary productivity gains.
While the above example focused on a dollar and cents, it is scalar. You can change the size by simply and accurately multiplying by millions, billions, trillions and so forth.

The solution set should not be limited to doing “something” when that something actually increases the risk level. There are better ways and means to deal with the problems.